# Morningstar, Inc. (MORN) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Morningstar, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1289419/000128941923000005/morn-20221231.htm
Accession: 0001289419-23-000005
Filing date: 2023-02-24
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/MORN/
All MD&A years: /company/MORN/mda/
Previous year: /company/MORN/mda/fy2021/ (FY 2021)
Next year: /company/MORN/mda/fy2023/ (FY 2023)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The discussion included in this section, as well as other under "Business--Our Strategy," "Business--Regulatory Trends Affecting Our Business" and sections of this report, contains forward-looking statements as that term is used in the Private Securities Litigation Reform Act of 1995. These statements are based on our current expectations about future events or future financial performance. Forward-looking statements by their nature address matters that are, to different degrees, uncertain, and often contain words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue.” These statements involve known and unknown risks and uncertainties that may cause the events we discuss not to occur or to differ significantly from what we expect. For us, these risks and uncertainties include, among others:

•failing to maintain and protect our brand, independence, and reputation;

•liability related to cybersecurity and the protection of confidential information, including personal information about individuals;

•compliance failures, regulatory action, or changes in laws applicable to our credit ratings operations, investment advisory, ESG and index businesses;

•failing to innovate our product and service offerings or anticipate our clients’ changing needs;

•prolonged volatility or downturns affecting the financial sector, global financial markets, and the global economy and its effect on our revenue from asset-based fees and credit ratings business;

•failing to recruit, develop, and retain qualified employees;

•liability for any losses that result from errors in our automated advisory tools;

•inadequacy of our operational risk management and business continuity programs in the event of a material disruptive event;

•failing to efficiently integrate and leverage acquisitions and other investments to produce the results we anticipate;

•failing to scale our operations and increase productivity and its effect on our ability to implement our business plan;

•failing to maintain growth across our businesses in today's fragmented geopolitical, regulatory and cultural world;

•liability relating to the information and data we collect, store, use, create, and distribute or the reports that we publish or are produced by our software products;

•the potential adverse effect of our indebtedness on our cash flows and financial flexibility;

•challenges in accounting for complexities in taxes in the global jurisdictions in which we operate could materially affect our tax obligations and tax rate; and

•failing to protect our intellectual property rights or claims of intellectual property infringement against us.

A more complete description of these risks and uncertainties can be found in Item 1A—Risk Factors of this report. If any of these risks and uncertainties materialize, our actual future results and other future events may vary significantly from what we expect. We do not undertake to update our forward-looking statements as a result of new information or future events.

This section includes comparisons of certain 2022 financial information to the same information for 2021. Year-to-year comparisons of the 2021 financial information to the same information for 2020 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.

All dollar and percentage comparisons, which are often accompanied by words such as “increase,” “decrease,” “grew,” “declined,” “was up,” “was down,” “was flat,” or “was similar”, refer to a comparison with the prior year unless otherwise stated. 

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Understanding Our Company

Key Business Characteristics

We offer an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors and other participants in the private capital markets. Many of our products are sold through subscriptions or license agreements. As a result, we typically generate recurring revenue.

Revenue

We generate revenue by selling a variety of investment-related products and services. We sell many of our products and services, including PitchBook, Morningstar Data, Morningstar Direct, Morningstar Sustainalytics, and Morningstar Advisor Workstation, through license agreements. Our license agreements typically range from one to three years. We sell some of our other products, such as Morningstar Investor Membership service, which represents subscription services available to customers and not a license under the accounting guidance, on Morningstar.com via subscriptions. These subscriptions are mainly offered for a one-year term, although we offer terms ranging from one month to three years.

Our investment management products have multiple fee structures, which vary by client and region. In general, we seek to receive asset-based fees for any work we perform that involves managing investments or acting as a subadvisor to investment portfolios. For any individual contract, we may receive flat fees, variable asset-based fees, or a combination of the two. Some of our contracts include minimum fee levels that provide us with a flat payment up to a specified asset level, above which we also receive variable asset-based fees. In most of our contracts that include variable asset-based fees, we bill clients quarterly in arrears based on average assets for the quarter. Other contracts may include provisions for monthly billing or billing based on assets as of the last day of the billing period rather than on average assets.

In our Workplace Solutions area, our contracts may include one-time setup fees, technology licensing fees, asset-based fees for managed retirement accounts, fixed and variable fees for advice and guidance, or a combination of these fee structures. We also offer plan sponsor advice and custom target-date consulting arrangements. Fees for these services may be based on the level of assets under advisement.

Firms license Morningstar Indexes for both product creation (where we typically receive the greater of a minimum fee or basis points tied to assets under management) and data licensing (where we typically receive annual licensing fees).

We also generate transaction-based revenue, primarily from DBRS Morningstar and from the sale of advertising on our websites and sponsorship of our conferences. For the year ended December 31, 2022, 57.6% of the revenue generated by DBRS Morningstar came from one-time, transaction-based fees driven by ratings on newly-issued securities; the remainder can be classified as transaction-related, with annual fees tied to surveillance, credit research, or other services.

Deferred Revenue

We invoice some of our clients and collect cash in advance of providing services or fulfilling subscription services to our customers. Deferred revenue totaled $489.1 million (of which $455.6 million was classified as a current liability with an additional $33.5 million included in other long-term liabilities) at the end of 2022. We expect to recognize this deferred revenue in future periods as we fulfill the service obligations under our license and subscription agreements.

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Operating Expense

We classify our operating expense into separate categories for cost of revenue, sales and marketing, general and administrative, and depreciation and amortization, as described below.

• Cost of revenue. This category includes compensation expense for employees who produce the products and services we deliver to our customers. For example, this category covers production teams and analysts who write investment research reports. It also includes compensation expense for programmers, designers, and other employees who develop new products and enhance existing products. In some cases, we capitalize the compensation costs associated with certain software development projects. This reduces the expense that we would otherwise report in this category. Cost of revenue also includes other expenses, such as third-party data purchases and data lines as well as professional fees for third-party development activities.

• Sales and marketing. This category includes compensation expense for our sales teams, product managers, and marketing professionals. We also include the cost of advertising, digital marketing campaigns, and other marketing and promotion efforts in this category.

• General and administrative. This category includes compensation expense for our management team and other corporate functions, including employees in our compliance, finance, human resources, and legal departments. It also includes costs for corporate systems and facilities.

• Depreciation and amortization. Our capital expenditures mainly relate to capitalized software development costs, information technology equipment, and leasehold improvements. We amortize capitalized software development costs over their estimated economic life, generally three years. We depreciate property and equipment using the straight-line method based on the useful lives of the assets, which range from three to seven years. We amortize leasehold improvements over the lease term or their useful lives, whichever is shorter. We also include amortization related to identifiable intangible assets, which is mainly driven by acquisitions, in this category. We amortize intangible assets using the straight-line method over their estimated economic useful lives, which range from one to twenty years.

International Operations

As of December 31, 2022, we had wholly- or majority-owned subsidiaries in 31 countries outside of the U.S. and included their results of operations and financial condition in our consolidated financial statements. We also have investments outside of the U.S., and where we have significant influence, we apply the equity method of accounting.

How We Evaluate Our Business

When our analysts evaluate a stock, they focus on assessing the company's estimated intrinsic value, which is based on estimated future cash flows, discounted to their value in today's dollars. Our approach to evaluating our own business works the same way.

Our goal is to increase the intrinsic value of our business over time, which we believe is the best way to create value for our shareholders. We do not make public financial forecasts for our business because we want to avoid creating any incentives for our management team to make speculative statements about our financial results that could influence our stock price or take actions that help us meet short-term forecasts, but may not build long-term shareholder value.

We provide the following measures that can help investors generate their own assessment of how our intrinsic value has changed over time:

    •    Revenue (including organic revenue);

    •    Operating income (loss) (including adjusted operating income);

    •    Operating margin (including adjusted operating margin); and

    •    Free cash flow.

Organic revenue, adjusted operating income, adjusted operating margin, and free cash flow are not measures of performance set forth under U.S. generally accepted accounting principles (GAAP).

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We define organic revenue as consolidated revenue excluding acquisitions, divestitures, adoption of new accounting standard changes (accounting changes), and foreign currency translations. We present organic revenue because we believe it helps investors better compare our period-to-period results, and our management team uses this measure to evaluate the performance of our business. We exclude revenue from businesses acquired or divested from organic revenue for a period of 12 months after we complete the acquisition or divestiture. Organic revenue is not equivalent to any measure required under GAAP and may not be comparable to similarly titled measures reported by other companies.

We define adjusted operating income as operating income excluding all M&A-related expenses (including M&A-related earn-outs) and amortization, as well as all expenses related to the significant reduction and shift of the company's operations in China. We define adjusted operating margin as operating margin excluding all M&A-related expenses (including M&A-related earn-outs) and amortization, as well as all expenses related to the significant reduction and shift of the company's operations in China. We present these measures because we believe they better reflect period-over-period comparisons and improves overall understanding of the underlying performance of the business absent the impact of M&A and the shift of the company's operations in China.

We define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow as supplemental information to help investors better understand trends in our business results over time. Our management team uses free cash flow to evaluate our business. Free cash flow is not equivalent to any measure required under GAAP and should not be considered an indicator of liquidity. Moreover, the free cash flow definition we use may not be comparable to similarly titled measures reported by other companies.

In addition to the measures described above, we calculate revenue renewal rates to evaluate how successful we've been in maintaining existing business for products and services that have revenue associated with periodic renewals. We use the annual contract value method, which tracks the dollar value of renewals compared with the total dollar value of contracts up for renewal during the period. We include changes in the contract value in the renewal amount. We also include variable-fee contracts in this calculation and use the actual revenue for the previous comparable fiscal period as the base rate for calculating the renewal percentage. The renewal rate excludes setup and customization fees and contract renewals that were pending as of January 31, 2023.

Regulatory Trends Affecting Our Business

As described more fully under “Government Regulation”, certain subsidiaries of Morningstar engage in lines of business or other activities that subject them to various laws and regulations specific to those businesses or activities. These regulated businesses or activities includes credit ratings, investment management, investment research, environmental, social, and governance (ESG) research, ratings and data, and indexes. In addition to the industry developments described under "Business - Our Strategy", there are several longer-term regulatory trends we consider relevant to our business, as outlined below.

Even in its fragmented state, regulators globally have continued to focus on certain recurring themes, including access to financial services, the quality of advice and the value of the services provided, the protection of customer data and transparency around the uses of such data, the minimization of conflicts of interest, and improvements in corporate governance and risk management.

With respect to our credit ratings business, the European Securities Markets Authority (ESMA) or the U.K. Financial Conduct Authority (FCA) may begin to make inconsistent modifications to the laws and regulations of the credit rating agency regulatory regimes, which would increase the cost and complexity of regulatory compliance for our credit ratings business.

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In the U.K. and Europe, with respect to our Investment Management business, Morningstar continues to navigate the equivalence regimes and domestic laws governing matters of access in financial services post-Brexit. In other parts of the world, recent regulations and other guidance in jurisdictions, like Australia and New Zealand, have focused on investment management compliance practices, such as design and distribution obligations, conflicts of interest and fee disclosures. The increased complexity and extent of regulatory change globally is a challenge for both Morningstar and its clients and we continue to expend resources to remain in compliance.

Interest from investors, regulators and other relevant stakeholders in firms adopting ESG related business and operational risk strategies persists. Morningstar is impacted by these trends on the corporate level, as a U.S. public company with international operations, and on a business level, as a provider of ESG data, ratings, insights and other services to help investors and advisors understand and inform their decisions. These developments will have long term impacts on our delivery of products and services, customer interactions, physical operations, technology systems, and dependencies on third parties. Given more intense regulatory scrutiny at multiple jurisdictional levels and the novelty of some of the issues presented, the possibilities for inadvertent noncompliance with regulation have increased.

Morningstar is monitoring proposed legislation in the EU relevant to its ESG business activities. The Sustainable Finance Disclosure Regulation requires various investment market participants to implement policies and make certain disclosures with regards to sustainability risks and sustainability factors relevant to their investment activities. We do not expect this disclosure requirement will have a material adverse effect on our business, operating results, or financial position.

The European Commission released its EuGBS proposal that, among other things, would set up a system for registering and supervising companies that act as external reviewers for green bonds aligned with the EuGBS Regulation framework. Morningstar Sustainalytics currently offers external reviews of green bonds that we expect may be in scope for the EuGBS Regulation. If adopted, the EuGBS Regulation would contain a suite of requirements covering the governance of external reviewers, as well as general principles requiring the external reviewer to employ appropriate systems, resources and procedures and to monitor and evaluate at least annually, the adequacy and effectiveness of its systems and internal control mechanisms and arrangements.

Regulators in other jurisdictions including Canada, China, India, Japan, and the UAE have also adopted or begun to work on frameworks related to ESG-disclosure and registration requirements applicable to ESG rating providers or green bond verifiers. While green bond issuances are on the rise in the U.S., there is no set framework or statutory definition in the U.S. for such financings. These and other potential regulations impact not only the scope and manner of the ESG related products and services we provide to customers, but also present an opportunity to guide and inform advisers and investors who are looking to understand the regulations and develop their own workflows to ensure their compliance with new requirements. From a corporate perspective, we are monitoring regulatory developments such as the EU’s Corporate Sustainability Reporting Directive and proposed SEC rules regarding climate and cybersecurity disclosure.

The politicization of ESG-related business activities and investments has increased in recent years, particularly in the U.S. This politicization has led to the rise of anti-ESG proponents and actions, including the submission of anti-ESG shareholder proposals to U.S.-based public companies and the filing of lawsuits against U.S. companies. As Morningstar provides data and analysis with respect to ESG-related investments, Morningstar, along with other financial service providers, faces scrutiny in this political environment and expends resources in responding to inquiries. Morningstar continues to monitor the ESG and anti-ESG landscape closely.

Data privacy regulation continues to proliferate, as numerous national and state jurisdictions are considering new data privacy regulations. The General Data Protection Regulation (GDPR) continues to be a major influence on the global privacy landscape. Many non-EU countries are following the EU’s lead and implementing rules similar to GDPR in their jurisdictions to enable cross-border data exchange.

In the U.S., the growing number of state privacy laws and the absence of a comprehensive federal privacy law have contributed to a challenging compliance environment. State privacy laws typically adopt similar themes as GDPR, limiting companies’ ability to process certain categories of personal data and extending to customers the right to control their data. These laws may provide obligations inconsistent with other state or global privacy regulations and impose additional compliance costs.

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As a related matter, issues of cybersecurity as they relate to the identification and mitigation of system vulnerabilities also continue to grow in prominence and laws governing data breaches continue to proliferate globally. Financial regulators have also increased scrutiny on the data protection practices of the entities, such as Morningstar, that they oversee. In the U.S., the SEC is focused on cybersecurity hygiene and preparedness, cyber incident reporting to the government, and in certain circumstances, disclosure to the public. This focus has the potential to impact not only Morningstar’s regulated businesses, but also those of its customers who may potentially need to implement increasing scrutiny of their service providers and commercial counterparties.

Finally, our company is impacted by government regulation and policies focused on macroeconomic trends such as inflation and unemployment and the COVID-19 pandemic. Central banks’ increases in interest rates to combat inflationary pressures increases our interest expense on our variable rate indebtedness, while the volatile rate environment reduces credit issuance putting negative pressure on our credit rating business. Our compensation expense reflects rising wage scales in many of the markets where we operate as unemployment rates remain low. Ongoing impacts from the COVID-19 pandemic include an increased number of our colleagues participating in hybrid working arrangements and some continued restrictions on travel to our office and customer locations. Overall, our business, balance sheet, technological infrastructure, and teams have shown resilience and flexibility navigating global macroeconomic trends.

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Supplemental Operating Metrics (Unaudited)

The tables below summarize our key product metrics and other supplemental data.

[[GREPCENT_TABLE]]
[["","","","Year ended December 31,"],["(in millions)","","2022","","2021","","2022 Change","","Organic Change (1)"],["Revenue by type"],["License-based (2)","","$","1,331.7","","","$","1,131.7","","","17.7","%","","18.0","%"],["Asset-based (3)","","269.4","","","264.9","","","1.7","%","","1.5","%"],["Transaction-based (4)","","269.5","","","302.7","","","(11.0)","%","","(8.3)","%"],["Key product area revenue"],["PitchBook","","$","407.7","","","$","290.2","","","40.5","%","","40.5","%"],["Morningstar Data","","255.0","","","243.5","","","4.7","%","","9.4","%"],["DBRS Morningstar (5)","","236.9","","","271.2","","","(12.6)","%","","(10.0)","%"],["Morningstar Direct","","184.8","","","173.2","","","6.7","%","","10.7","%"],["Investment Management","","117.6","","","125.5","","","(6.3)","%","","(4.3)","%"],["Workplace Solutions","","103.7","","","104.4","","","(0.7)","%","","(0.7)","%"],["Morningstar Sustainalytics","","103.0","","","78.9","","","30.5","%","","41.0","%"],["Morningstar Advisor Workstation","","95.4","","","91.9","","","3.8","%","","4.1","%"],["","","","As of December 31,"],["Assets under management and advisement (approximate) ($bil) (6)","","2022","","2021","","2022 Change"],["","Workplace Solutions"],["","Managed Accounts (7)","","$","109.3","","","$","111.1","","","(1.6)","%"],["","Fiduciary Services","","50.4","","","60.2","","","(16.3)","%"],["","Custom Models/CIT","","34.9","","","41.6","","","(16.1)","%"],["","Workplace Solutions (total)","","$","194.6","","","$","212.9","","","(8.6)","%"],["","Investment Management"],["","Morningstar Managed Portfolios","","$","32.6","","","$","32.4","","","0.6","%"],["","Institutional Asset Management","","9.8","","","11.8","","","(16.9)","%"],["","Asset Allocation Services","","8.5","","","8.0","","","6.3","%"],["","Investment Management (total)","","$","50.9","","","$","52.2","","","(2.5)","%"],["Asset value linked to Morningstar Indexes ($bil)","","$","147.7","","","$","147.0","","","0.5","%"],["Our employees"],["","Worldwide headcount","","12,224","","","9,556","","","27.9","%"],["Average assets under management and advisement ($bil)","","$","253.6","","","$","249.4","","","1.7","%"]]
[[/GREPCENT_TABLE]]

(1) Organic revenue excludes acquisitions, divestitures, adoption of new accounting standard changes (accounting changes), and the effect of foreign currency translations.

(2) License-based revenue includes PitchBook, Morningstar Data, Morningstar Direct, Morningstar Sustainalytics, Morningstar Advisor Workstation, and other similar products.

(3) Asset-based revenue includes Investment Management, Workplace Solutions, and Morningstar Indexes.

(4) Transaction-based revenue includes DBRS Morningstar, Internet advertising, and Morningstar-sponsored conferences.

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(5) For the years ended December 31, 2022 and 2021, DBRS Morningstar recurring revenue derived primarily from surveillance, research, and other transaction-related services was 42.4% and 34.3%, respectively.

(6) The asset totals shown below (including assets we either manage directly or for which we provide consulting or subadvisory work) only include assets for which we receive variable fees based on basis-points of asset balances. Some of our client contracts include services for which we receive a flat fee, but we do not include those assets in the total reported.

Excluding changes related to new contracts and cancellations, changes in the value of assets under advisement can come from two primary sources: gains or losses related to overall trends in market performance and net inflows or outflows caused when investors add to or redeem shares from these portfolios.

Aside from Morningstar Managed Portfolios, it's difficult for our Investment Management business to quantify these cash inflows and outflows. The information we receive from most of our clients does not separately identify the effect of cash inflows and outflows on asset balances for each period. We also cannot specify the effect of market appreciation or depreciation because the majority of our clients have discretionary authority to implement their own portfolio allocations.

(7) Many factors can cause changes in assets under management and advisement for our managed retirement accounts, including employer and employee contributions, plan administrative fees, market movements, and participant loans and hardship withdrawals. The information we receive from the plan providers does not separately identify these transactions or the changes in balances caused by market movements.

Consolidated Results

[[GREPCENT_TABLE]]
[["Key metrics (in millions)","","2022","","2021","","Change"],["Revenue","","$","1,870.6","","","$","1,699.3","","","10.1","%"],["Operating income","","167.8","","","257.0","","","(34.7)","%"],["Operating margin","","9.0","%","","15.1","%","","(6.1)pp"],["Cash provided by operating activities","","$","297.8","","","$","449.9","","","(33.8)","%"],["Capital expenditures","","(129.5)","","","(101.8)","","","27.2","%"],["Free cash flow","","$","168.3","","","$","348.1","","","(51.7)","%"],["Cash used for investing activities","","$","(799.3)","","","$","(167.7)","","","376.6","%"],["Cash provided by (used for) financing activities","","$","415.1","","","$","(211.8)","","","(296.0)","%"]]
[[/GREPCENT_TABLE]]

 ___________________________________________________________________________________________

pp — percentage points

Consolidated Revenue

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021","","Change"],["Consolidated revenue","","$","1,870.6","","","$","1,699.3","","","10.1","%"]]
[[/GREPCENT_TABLE]]

In 2022, our consolidated revenue rose $171.3 million, or 10.1%. Foreign currency movements decreased revenue by $45.9 million in 2022.

License-based revenue, which represents subscription services available to customers, increased 17.7% , or 18.0% on an organic basis, during 2022, driven by demand for license-based products, such as PitchBook, Morningstar Sustainalytics, and Morningstar Direct. Licensed-based organic revenue grew 18.0%. PitchBook revenue increased 40.5% on a reported and organic basis during 2022, as the company continued to enhance core data sets and improve the user experience. Reported and organic results exclude contributions from the LCD acquisition. In 2022, PitchBook added new companies and funds to coverage in the Europe, Middle East, and Africa (EMEA) and Asia-Pacific regions, while enhancing alternative data sets including real assets and hedge funds. Notable product releases included Portfolio Forecasting, a tool that allows Limited Partners to efficiently manage cash flow, pace commitments, and hit allocation targets directly within the PitchBook Platform. The number of PitchBook Platform licenses increased to 94,628 at the end of 2022, compared with 73,940 at the end of 2021.

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Morningstar Sustainalytics revenue grew 30.5%, or 41.0% on an organic basis, driven by strength in its licensing business, including demand for compliance and reporting-related solutions related to the EU Action Plan, as asset managers continued to look to Morningstar Sustainalytics to help them meet the various EU regulatory requirements. In 2022, Morningstar Sustainalytics increased its ratings coverage by approximately 30% to cover more than 16,300 analyst-based ESG Risk Ratings, while expanding its EU Action Plan Solutions suite.

Morningstar Direct grew revenue by 6.7%, or 10.7% on an organic basis, driven by growth across geographies. Direct licenses increased 5.7%, reflecting gains from both new and existing clients. In 2022, Morningstar Direct enriched and expanded Analytics Lab, which combines access to Morningstar's data and research with Jupyter Notebook, an open-source data-science tool, to allow clients to explore and analyze Morningstar data more efficiently in a flexible environment. We also released the Sustainability and Portfolio Hubs, which act as a central repository of research and tools for related workflows, and broadened data coverage in fixed-income, exchange-traded funds (ETFs), ESG, model portfolios, and alternatives to better cover investor portfolios.

Morningstar Data revenue grew 4.7%, or 9.4% on an organic basis, driven by growth across geographies and strong demand for fund data. In 2022, Morningstar Data expanded the reach of its data sets to better cover the client portfolio with enhancements to fixed-income data and analytics and expanded coverage of 529 plan portfolios, public equities, collective investment trusts, and model portfolios. We also introduced new regulatory data solutions in response to global investor protection, capital adequacy, and sustainability regulations.

Asset-based revenue increased 1.7%, or 1.5% on an organic basis, during 2022, as growth in Morningstar Indexes revenue was largely offset by market-driven declines in Investment Management revenue. Morningstar Indexes revenue increased 35.5%, or 26.2% on an organic basis, due primarily to strength in investable and licensed data products. Organic revenue excludes LCD index-related revenue. In 2022, Morningstar Indexes launched more than 50 investable products including the Global X Morningstar Japan Dividend ESG ETF and six iShares mutual funds tracking the Morningstar ESG Enhanced Index series. We also completed the acquisition, integration, and rebranding of the LCD Leveraged Loan Indexes under the Morningstar Indexes umbrella and launched the Morningstar PitchBook Global Unicorn Indexes in collaboration with PitchBook.

Investment Management revenue was 6.3% lower in 2022 and 4.3% lower on an organic basis. Reported assets under management and advisement fell 2.5% versus the prior year period, reflecting the declines in global markets and softer net flows. Excluding $4.4 billion of assets related to the acquisition of Praemium's U.K. and international offerings in the second quarter of 2022, assets would have declined 10.9% compared with the prior-year period. In 2022, the company successfully closed the Praemium acquisition, which expanded its wealth management capabilities outside the U.S. During 2022, Investment Management also continued to enhance the advisor and client experience on its turnkey asset management platform and introduced direct indexing, which allows advisors to personalize index portfolios to address individual preferences and tax management needs, as part of an ongoing strategy to build a comprehensive Wealth platform leveraging capabilities across Morningstar.

Transaction-based revenue decreased 11.0%, or 8.3% on an organic basis, during 2022 as DBRS Morningstar revenue declined, reflecting a sharp decrease in credit issuance in the second half of the year. DBRS Morningstar revenue declined 12.6%, or 10.0% on an organic basis. Revenue decreased across all geographies and most product areas during the year, with significant declines in commercial- and residential-mortgage backed securities ratings. In 2022, areas of investment included U.S. and European corporates, asset-based securities, and data products. Despite the challenging ratings environment, revenue grew for data products and U.S. corporates. Specifically for U.S. corporates, growth was driven by the addition of coverage and ratings for new middle-market credits. Annual fees tied to surveillance, research, and other services represented 42.4% of DBRS Morningstar revenue.

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Organic revenue

Organic revenue (revenue excluding acquisitions, divestitures, adoption of new accounting standard changes (accounting changes), and the effect of foreign currency translations) is considered a non-GAAP financial measure. The definition of organic revenue we use may not be the same as similarly titled measures used by other companies. Organic revenue should not be considered an alternative to any measure of performance as required under GAAP.

We present organic revenue because we believe it helps investors better compare our period-to-period results, and our management team uses this measure to evaluate the performance of our business and product areas. We exclude revenue from acquired businesses from our organic revenue growth calculation for a period of 12 months after we complete the acquisition. For divestitures, we exclude revenue in the prior period for which there is no comparable revenue in the current period.

Excluding revenue from acquisitions, accounting changes, and the impact of foreign currency translations, organic revenue increased 10.8% in 2022. PitchBook, Morningstar Sustainalytics, Morningstar Data, and Morningstar Direct were the main drivers of the increase in organic revenue during 2022.

The tables below reconcile consolidated revenue with organic revenue: 

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021","","Change"],["Consolidated revenue","","$","1,870.6","","","$","1,699.3","","","10.1","%"],["Less: acquisitions","","(40.9)","","","\u2014","","","NMF"],["Less: accounting changes","","\u2014","","","(5.8)","","","NMF"],["Effect of foreign currency translations","","45.9","","","\u2014","","","NMF"],["Organic revenue","","$","1,875.6","","","$","1,693.5","","","10.8","%"]]
[[/GREPCENT_TABLE]]

____________________________________________________________________________________________

NMF — Not meaningful

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Revenue by geographical area

[[GREPCENT_TABLE]]
[["","","Year ended December 31"],["(in millions)","","2022","","2021","","Change"],["United States","","$","1,353.9","","","$","1,184.3","","","14.3","%"],["Asia","","44.8","","","41.1","","","9.0","%"],["Australia","","55.8","","","56.9","","","(1.9)","%"],["Canada","","109.8","","","112.9","","","(2.7)","%"],["Continental Europe","","162.9","","","159.1","","","2.4","%"],["United Kingdom","","133.6","","","135.7","","","(1.5)","%"],["Other","","9.8","","","9.3","","","5.4","%"],["Total International","","516.7","","","515.0","","","0.3","%"],["Consolidated revenue","","$","1,870.6","","","$","1,699.3","","","10.1","%"]]
[[/GREPCENT_TABLE]]

International revenue comprised approximately 28% and 30% of our consolidated revenue in 2022 and 2021, respectively. Approximately 57% of international revenue is generated from Continental Europe and the U.K.

Revenue from international operations increased $1.7 million, or 0.3%, in 2022. Acquisitions had a favorable impact of $1.8 million, while foreign currency translations had an unfavorable impact of $45.9 million in 2022.

Revenue Renewal Rates

As discussed in How We Evaluate Our Business, we calculate revenue renewal rates to help measure how successful we've been in maintaining existing business for products and services that have renewable revenue. The figures for license-based products includes the effect of price changes; increasing client bases upon contract renewal; changes to the contract value upon renewal (such as increased users); and changes in the value of variable-fee contracts. These factors, therefore, can result in a renewal rate percentage greater than 100%.

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Our revenue renewal rate calculation includes only those products that we consider to be license-based. These are primarily weighted toward PitchBook, Morningstar Data, Morningstar Direct, and Morningstar Advisor Workstation, but also includes other license-based products and services across Morningstar. For these license-based products and services, we estimate that our annual renewal rate was approximately 105% in 2022 versus 104% in 2021.

Consolidated Operating Expense

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021","","","","Change"],["Cost of revenue","","$","779.3","","","$","698.4","","","","","11.6","%"],["% of revenue","","41.7","%","","41.1","%","","","","0.6","pp"],["Sales and marketing","","356.5","","","274.8","","","","","29.7","%"],["% of revenue","","19.1","%","","16.2","%","","","","2.9","pp"],["General and administrative","","400.4","","","318.4","","","","","25.8","%"],["% of revenue","","21.4","%","","18.7","%","","","","2.7","pp"],["Depreciation and amortization","","166.6","","","150.7","","","","","10.6","%"],["% of revenue","","8.9","%","","8.9","%","","","","\u2014","","pp"],["Total operating expense","","$","1,702.8","","","$","1,442.3","","","","","18.1","%"],["% of revenue","","91.0","%","","84.9","%","","","","6.1","pp"]]
[[/GREPCENT_TABLE]]

In 2022, operating expense increased $260.5 million, or 18.1%.

In July 2022, the company began to significantly reduce its operations in Shenzhen, China and to shift the work related to its global business functions, including global product and software development, managed investment data collection and analysis, and equity data collection and analysis, to other Morningstar locations. These activities will result in a significant headcount reduction in Shenzhen, China and growth in other Morningstar locations including Mumbai, Toronto, Madrid, and Chicago. Going forward, the company's work in China will be focused solely on commercial activities in the domestic market.

The company expects that these activities will be substantially complete by the end of the third quarter of 2023 and will result in lower ongoing run-rate costs from the overall net reduction in the related headcount and certain overhead. Excluding the impact of these activities, operating expenses increased 15.6% during 2022.

Higher compensation expense (which primarily consists of salaries, bonuses, and other company-sponsored benefits), stock-based compensation costs, professional fees, severance expense, and sales commission expense were the key contributors to operating expense growth in 2022. Foreign currency translations had a favorable impact of $48.2 million on operating expense in 2022.

Compensation expense (which primarily consists of salaries, bonuses, and other company-sponsored benefits) increased $81.5 million in 2022. Excluding the impact of an earn-out accrual related to our acquisition of Sustainalytics, compensation expense increased $97.9 million during 2022. These higher costs reflect growth in headcount across key areas of the company, including product and software development, data collection and analysis, sales, and service support, in addition to annual merit increases effective January 1, 2022. The growth in headcount was highest in Morningstar Sustainalytics and PitchBook to support our strategic growth initiatives. Inflationary pressures and a competitive market for talent in many of our key geographies put further pressure on compensation expense.

Stock-based compensation expense increased $41.3 million in 2022, primarily as a result of the overachievement of targets under the PitchBook management bonus plan.

Professional fees increased $28.0 million in 2022, due primarily to the use of third-party resources assisting with software development and technology improvements, M&A-related services, and costs associated with the company's initiation of the significant reduction and shift of its China operations. Professional fees also reflected the impact of higher legal fees primarily associated with a completed independent investigation regarding certain research practices of Morningstar Sustainalytics.

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Severance expense increased $27.1 million in 2022, primarily caused by severance packages offered to the employees impacted by the company's initiation of the significant reduction of its China operations.

Sales commission expense increased $19.4 million in 2022, from strong sales performance in license-based product areas and higher amortization of capitalized commissions related to the prior-year sales performance.

An increase of $9.4 million in capitalized software development related to increased product development efforts for our key product areas reduced operating expense in 2022.

We had 12,224 employees worldwide at the end of 2022, compared with 9,556 at the end of 2021, which reflects further investments to support our growth objectives noted above.

Cost of revenue

Cost of revenue is our largest category of operating expense, representing about one-half of our total operating expense. Our business relies heavily on human capital, and cost of revenue includes the compensation expense for employees who produce our products and services. We include compensation expense for approximately 80% of our employees in this category.

Cost of revenue increased $80.9 million, or 11.6%, in 2022. Higher compensation expense of $50.0 million was the largest contributor to the increase, primarily due to the factors listed above. Professional fees increased $9.6 million in 2022 related to higher legal fees and the use of third-party resources assisting with software development and technology improvements. These increases were partially offset by higher capitalized software expense of $9.4 million, which resulted from an increase in development activity in key product areas.

Continuous focus on the development of our major software platforms for our key product areas, in addition to bringing new products and capabilities to market, resulted in an increase in capitalized software development over the prior year period, which in turn reduced operating expense. In 2022, we capitalized $88.3 million associated with software development activities, mainly related to accelerated product development efforts for our key product areas and enhanced capabilities in our products, internal infrastructure, and software, compared with $79.0 million in 2021.

Sales and marketing

Sales and marketing expense increased $81.7 million, or 29.7%, in 2022. Higher compensation expense of $37.7 million was the largest contributor. Sales commission expense grew by $17.5 million due to stronger sales performance in license-based product areas and higher amortization of capitalized commissions related to prior-year sales performance. Advertising and marketing costs increased $10.7 million during 2022 due to higher conference expense and pay-per-click advertising.

General and administrative

General and administrative expense increased $82.0 million, or 25.8%, in 2022. Severance expense of $25.8 million related to severance packages offered to the employees impacted by the company's initiation of the significant reduction of its China operations contributed almost one-third of the increase. Stock-based compensation expense increased $32.1 million primarily due to the overachievement of targets under the PitchBook management bonus plan. Professional fees grew by $17.2 million, driven by the use of third-party resources assisting with software development and technology improvements, M&A-related services, and costs associated with the company's initiation of the significant reduction and shift of its operations in China. In addition, professional fees reflected higher legal fees primarily associated with the completed independent investigation regarding certain research practices of Morningstar Sustainalytics. These increases were offset by a decrease in compensation expense of $6.1 million compared with the prior year, which included a $23.5 million increase to an earn-out accrual related to our acquisition of Sustainalytics.

Depreciation and amortization

In 2022, depreciation and amortization increased $15.9 million, or 10.6%, primarily due to depreciation expense.

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Depreciation expense increased $10.8 million in 2022, driven mainly by depreciation expense from increases in capitalized software development incurred over the past several years.

Intangible amortization expense increased $4.7 million in 2022, primarily from additional amortization related to intangibles from the acquisition of LCD and Praemium Portfolio Services Limited.

Consolidated Operating Income and Operating Margin

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021","","Change"],["Operating income","","$","167.8","","","$","257.0","","","(34.7)","%"],["Operating margin","","9.0","%","","15.1","%","","(6.1)","pp"]]
[[/GREPCENT_TABLE]]

Consolidated operating income decreased $89.2 million in 2022, reflecting an increase in operating expense of $260.5 million, which was partially offset by an increase in revenue of $171.3 million. Operating margin was 9.0% in 2022, a decrease of 6.1 percentage points compared with 2021. The year-over-year decline in margin resulted from increased compensation, stock-based compensation, severance expense, professional fees, and sales commission expense.

In 2022, we reported adjusted operating income of $298.9 million, which excludes intangible amortization expense, M&A-related expenses (including M&A-related earn-outs), and expenses related to the significant reduction and shift of the company's operations in China. Adjusted operating income is a non-GAAP financial measure; the table below shows a reconciliation to the most directly comparable GAAP financial measure.

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021","","Change"],["Operating income","","$","167.8","","","$","257.0","","","(34.7)","%"],["Add: intangible amortization expense","","66.7","","","62.0","","","7.6","%"],["Add: M&A-related expenses","","17.1","","","17.4","","","(1.7)","%"],["Add: M&A-related earn-outs","","11.6","","","27.0","","","(57.0)","%"],["Add: Severance and personnel expenses (1)","","27.5","","","\u2014","","","NMF"],["Add: Transformation costs (1)","","8.2","","","\u2014","","","NMF"],["Add: Asset impairment costs (1)","","\u2014","","","\u2014","","","\u2014","%"],["Adjusted operating income","","$","298.9","","","$","363.4","","","(17.7)","%"]]
[[/GREPCENT_TABLE]]

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In 2022, we reported an adjusted operating margin of 16.0%, which excludes intangible amortization expense, M&A-related expenses (including M&A-related earn-outs), and expenses related to the significant reduction and shift of the company's operations in China. Adjusted operating margin is a non-GAAP financial measure; the table below shows a reconciliation to the most directly comparable GAAP financial measure.

[[GREPCENT_TABLE]]
[["","","2022","","2021","","Change"],["Operating margin","","9.0","%","","15.1","%","","(6.1) pp"],["Add: intangible amortization expense","","3.6","%","","3.6","%","","\u2014 pp"],["Add: M&A-related expenses","","0.9","%","","1.0","%","","(0.1) pp"],["Add: M&A-related earn-outs","","0.6","%","","1.6","%","","(1.0) pp"],["Add: Severance and personnel expenses (1)","","1.5","%","","\u2014","%","","1.5 pp"],["Add: Transformation costs (1)","","0.4","%","","\u2014","%","","0.4 pp"],["Add: Asset impairment costs (1)","","\u2014","%","","\u2014","%","","\u2014 pp"],["Adjusted operating margin","","16.0","%","","21.3","%","","(5.3) pp"]]
[[/GREPCENT_TABLE]]

______________________________________________________________________________________________________

(1) Reflects costs associated with the significant reduction of the company's operations in Shenzhen, China and the shift of work related to its global business functions to other Morningstar locations.

Severance and personnel expenses include severance charges, incentive payments related to early signing of severance agreements, transition bonuses, and stock-based compensation related to the accelerated expense recognition from the continued vesting of restricted stock unit (RSU) and market stock unit (MSU) awards. In addition, the reversal of accrued sabbatical liabilities is included in this category.

Transformation costs include professional fees and the temporary duplication of headcount. As the company hires replacement roles in other markets and shifts capabilities, it expects to continue to employ certain Shenzhen-based staff through the transition period, which will result in elevated compensation costs on a temporary basis.

Asset impairment costs include the write-off or accelerated depreciation of fixed assets in the Shenzhen, China office that are not redeployed, in addition to lease abandonment costs as the company plans to downsize office space prior to the lease termination date.

Non-Operating Expense, Net, Equity in Net Income (Loss) of Unconsolidated Entities, and Effective Tax Rate and Income Tax Expense

Non-Operating Expense, Net

The following table presents the components of non-operating expense, net:

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021"],["Interest income","","$","1.7","","","$","1.7"],["Interest expense","","(30.1)","","","(10.4)"],["Realized gains (losses) on sale of investments, reclassified from other comprehensive income","","(2.1)","","","5.0"],["Realized gains on sale of equity method investments","","\u2014","","","0.9"],["Other expense, net","","(6.7)","","","(3.7)"],["Non-operating expense, net","","$","(37.2)","","","$","(6.5)"]]
[[/GREPCENT_TABLE]]

Interest income reflects interest from our investment portfolio. Interest expense mainly relates to the outstanding principal balance under our Amended 2022 Credit Agreement and the $350.0 million aggregate principal amount of 2.32% senior notes due October 26, 2030 (2030 Notes).

Other expense, net includes foreign currency exchange losses and unrealized gains (losses) on investments.

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Equity in Net Income (Loss) of Unconsolidated Entities

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021"],["Equity in net income (loss) of unconsolidated entities","","$","(3.6)","","","$","5.4"]]
[[/GREPCENT_TABLE]]

Equity in net income (loss) of unconsolidated entities primarily reflects income and losses from certain of our unconsolidated entities.

We describe our investments in unconsolidated entities in more detail in Note 9 of the Notes to our Consolidated Financial Statements.

Effective Tax Rate and Income Tax Expense

The following table summarizes the components of our effective tax rate:

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021"],["Income before income taxes and equity in net income (loss) of unconsolidated entities","","$","130.6","","","$","250.5"],["Equity in net income (loss) of unconsolidated entities","","(3.6)","","","5.4"],["Total","","$","127.0","","","$","255.9"],["Income tax expense","","$","56.5","","","$","62.6"],["Effective tax rate","","44.5","%","","24.5","%"]]
[[/GREPCENT_TABLE]]

Our effective tax rate in 2022 was 44.5%, an increase of 20.0 percentage points compared with 24.5% in 2021. The increase was primarily attributable to minimum taxes, non-deductible expenses, and additional reserves for uncertain tax positions.

Liquidity and Capital Resources

As of December 31, 2022, we had cash, cash equivalents, and investments of $414.6 million, down $131.5 million from the end of 2021.

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Cash provided by operating activities is our main source of cash. In 2022, cash provided by operating activities was $297.8 million, reflecting $309.8 million of net income, adjusted for non-cash items, and an additional $12.0 million in negative changes from our net operating assets and liabilities. Cash provided by operating activities decreased $152.1 million, or 33.8%, in 2022. Cash flow was negatively impacted by higher bonus payouts in the first quarter of 2022 related to 2021 annual performance.

On July 2, 2019, we entered into a senior credit agreement (the 2019 Credit Agreement). The 2019 Credit Agreement provided the company with a five-year multi-currency credit facility with an initial borrowing capacity of up to $750.0 million, including a $300.0 million revolving credit facility (the 2019 Revolving Credit Facility) and a term loan facility of $450.0 million. On May 6, 2022, the company terminated the 2019 Credit Agreement.

On May 6, 2022, the company entered into a new senior credit agreement (the 2022 Credit Agreement). The 2022 Credit Agreement provided the company with a five-year multi-currency credit facility with an initial borrowing capacity of up to $1.1 billion, including a $650.0 million term loan (the 2022 Term Facility) with an initial draw of $600.0 million and an option for a second draw of up to $50.0 million and a $450.0 million revolving credit facility (the 2022 Revolving Credit Facility). The 2022 Credit Agreement also provided for the issuance of up to $50.0 million of letters of credit and a $100.0 million sub-limit for a swingline.

The proceeds of the first draw under the 2022 Term Facility and initial borrowings under the 2022 Revolving Credit Facility were used to finance the acquisition of LCD and to repay a portion of the borrowings under the 2019 Revolving Credit Facility. The optional second draw on the 2022 Term Facility was available to fund the contingent consideration payment of up to $50.0 million in connection with the LCD acquisition.

The 2022 Credit Agreement was amended (the Amended 2022 Credit Agreement) on September 13, 2022 (the First Amendment to the 2022 Credit Agreement) and on September 30, 2022 (the Second Amendment to the 2022 Credit Agreement). The First Amendment to the 2022 Credit Agreement terminated the unfunded term commitment related to the optional second draw of up to $50.0 million in the 2022 Term Facility and increased the 2022 Revolving Credit Facility to $600.0 million. The Second Amendment to the 2022 Credit Agreement increased the 2022 Term Facility to a fully funded $650.0 million facility (the Amended 2022 Term Facility) and increased the 2022 Revolving Credit Facility to $650.0 million (the Amended 2022 Revolving Credit Facility) for total borrowing capacity of $1.3 billion. As of December 31, 2022, our total outstanding debt under the Amended 2022 Credit Agreement was $761.1 million, net of debt issuance costs, with borrowing availability of $530.0 million under the 2022 Revolving Credit Facility. Except for incremental borrowing capacity, there were no material changes to the existing terms and conditions of the 2022 Credit Agreement.

The proceeds of the additional draw under the Amended 2022 Term Facility were used to repay borrowings under the 2022 Revolving Credit Facility. The proceeds of future borrowings under the Amended 2022 Revolving Credit Facility may be used for working capital, capital expenditures, or other general corporate purposes. See Note 3 of the Notes to our Consolidated Financial Statements for additional information on our Amended 2022 Credit Agreement.

On October 26, 2020, we completed the issuance and sale of $350.0 million aggregate principal amount of 2.32% senior notes due October 26, 2030 (2030 Notes), in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. Proceeds were primarily used to pay off a portion of the company's outstanding debt under the 2019 Credit Agreement. Interest on the 2030 Notes will be paid semi-annually on each October 30 and April 30 during the term of the 2030 Notes and at maturity. As of December 31, 2022, our total outstanding debt, net of issuance costs, under the 2030 Notes was $348.5 million. See Note 3 of the Notes to our Consolidated Financial Statements for additional information on our 2030 Notes.

Each of the Amended 2022 Credit Agreement and the 2030 Notes include customary representations, warranties, and covenants, including financial covenants, that require us to maintain specified ratios of consolidated earnings before interest, taxes, depreciation, and amortization (EBITDA) to consolidated interest charges and consolidated funded indebtedness to consolidated EBITDA, which are tested on a quarterly basis. We were in compliance with these financial covenants as of December 31, 2022, with consolidated funded indebtedness to consolidated EBITDA calculated at approximately 2.2x.

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We believe our available cash balances and investments, along with cash generated from operations and our credit facility, will be sufficient to meet our operating and cash needs for at least the next 12 months. We are focused on maintaining a strong balance sheet and liquidity position. We hold our cash reserves in cash equivalents and investments and maintain a conservative investment policy. We invest most of our investment balance in stocks, bonds, options, mutual funds, money market funds, or exchange-traded products that replicate the model portfolios and strategies created by Morningstar. These investment accounts may also include exchange-traded products where Morningstar is an index provider.

Approximately 64% of our cash, cash equivalents, and investments as of December 31, 2022 were held by our operations outside the U.S., up from 57% as of December 31, 2021. We generally consider our U.S. directly-owned foreign subsidiary earnings to be permanently reinvested.

We intend to use our cash, cash equivalents, and investments for general corporate purposes, including working capital and funding future growth.

In December 2020, the board of directors approved a share repurchase program that authorizes the company to repurchase up to $400.0 million in shares of the company's outstanding common stock. As of December 31, 2022, we repurchased a total of 887,774 shares for $227.3 million under this authorization.

On December 6, 2022, the board of directors approved a new share repurchase program that authorizes the company to repurchase up to $500.0 million in shares of the company's outstanding common stock, effective January 1, 2023. The new program will replace the existing program and the new authorization expires on December 31, 2025.

In 2022, we also paid dividends of $61.5 million. While subsequent dividends will be subject to board approval, we expect to make regular quarterly dividend payments of 37.5 cents per share in 2023.

We expect to continue making capital expenditures in 2023, primarily for computer hardware and software provided by third parties, internally developed software, and leasehold improvements for new and existing office locations. We continue to adopt more public cloud and software-as-a-service applications for new initiatives and are in the process of migrating relevant parts of our data centers to the public cloud over the next several years. During this migration, we expect to run certain applications and infrastructure in parallel. These actions will continue to have some transitional effects on our level of capital expenditures and operating expenses.

On January 27, 2023, we entered into a Termination Agreement (the Termination Agreement) with MJKK, and a Tender Offer Agreement (the Tender Offer Agreement) with SBI Global Asset Management Co., Ltd. (SBI).

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Pursuant to the Termination Agreement, MJKK will cease use of the Morningstar brand and Morningstar and MJKK agreed to terminate the License Agreement originally entered into in 1998. As consideration for the transaction, Morningstar agreed to pay MJKK 8 billion Japanese yen, comprised of 6 billion Japanese yen (approximately $45.0 million), paid upon termination of the License Agreement on March 30, 2023, and a contingent payment of 2 billion Japanese yen (approximately $15.0 million), paid upon the achievement of certain conditions related primarily to the termination of the use of the Morningstar brand by MJKK’s customers.

As part of such transaction, pursuant to the Tender Offer Agreement, Morningstar agreed to tender up to 10 million shares in MJKK to SBI. The tender period is expected to conclude on February 28, 2023.

On February 6, 2023, we made a cash payment of $50.0 million, resolving our contingent consideration liability related to our acquisition of LCD.

We also expect to use a portion of our cash and investments balances in the first quarter of 2023 to make annual bonus payments of approximately $99.2 million related to the 2022 bonus program compared with $139.9 million paid in the first quarter of 2022 for the 2021 bonus program.

Consolidated Free Cash Flow

As described in more detail above, we define free cash flow as cash provided by or used for operating activities less capital expenditures. We present free cash flow solely as supplemental disclosure to help investors better understand how much cash is available after we spend money to operate our business. Our management team uses free cash flow to evaluate our business. Free cash flow is not a measure of performance. Also, the free cash flow definition we use may not be comparable to similarly titled measures used by other companies.

[[GREPCENT_TABLE]]
[["(in millions)","","2022","","2021","","","","Change"],["Cash provided by operating activities","","$","297.8","","","$","449.9","","","","","(33.8)","%"],["Capital expenditures","","(129.5)","","","(101.8)","","","","","27.2","%"],["Free cash flow","","$","168.3","","","$","348.1","","","","","(51.7)","%"]]
[[/GREPCENT_TABLE]]

We generated free cash flow of $168.3 million in 2022, a decrease of $179.8 million compared with 2021. The change reflects a $152.1 million decrease in cash provided by operating activities as well as a $27.7 million increase in capital expenditures. The decline in free cash flow was due primarily to lower cash earnings, higher bonus payments made in 2022 related to 2021 performance, higher interest expense, and an increase in capital expenditures driven in large part by higher software development costs. Capital expenditures increased due to investments in office build-outs and refreshes, in addition to increased capitalized software development activities. Excluding $40.0 million and $16.6 million of M&A-related earn-out payments in the second quarter of 2022 and 2021, respectively, operating cash and free cash flow would have declined by 27.6% and 42.9%, respectively.

Acquisitions

We paid a total of $739.3 million, less cash acquired, related to acquisitions over the past three years. We describe these acquisitions in Note 8 of the Notes to our Consolidated Financial Statements.

We paid a total of $65.9 million related to additional investments in unconsolidated entities over the past three years. We describe these investments in Note 9 of the Notes to our Consolidated Financial Statements.

Divestitures

We had no divestitures in 2022, 2021, or 2020.

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Application of Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our Consolidated Financial Statements, which have been prepared in accordance with GAAP. We discuss our significant accounting policies in Note 2 of the Notes to our Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires our management team to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense, and related disclosures included in our Consolidated Financial Statements.

We continually evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe are reasonable. Based on these assumptions and estimates, we make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results could vary from these estimates and assumptions. If actual amounts are different from previous estimates, we include revisions in our results of operations for the period in which the actual amounts become known.

We believe the following critical accounting policies reflect the significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

Revenue Recognition

Most of our revenue comes from the sale of subscriptions for data, software, and Internet-based products and services. We recognize this revenue in equal amounts over the term of the subscription or license, which generally ranges from one to three years. Our license-based revenue represents subscription services available to customers and not a license under the accounting guidance. We also provide research, investment management, retirement advice, and other services. We recognize this revenue when the service is provided or during the service obligation period defined in the contract.

We make judgments related to revenue recognition, including allocating the transaction price in a contract. For contracts that combine multiple products and services or other performance obligations, we make judgments regarding the value of each obligation in the arrangement based on selling prices of the items as if sold separately. We recognize revenue as we satisfy our performance obligations under the terms of the contracts with our customers. If arrangements include an acceptance provision, which exists infrequently, we begin recognizing revenue upon the receipt of customer acceptance.

We make judgments at the beginning of an arrangement regarding whether collection of the consideration to which we are entitled is probable. We typically sell to institutional customers with whom we have a history of successful collections and assess the likelihood of collection on a customer-by-customer basis.

Deferred revenue is the amount collected in advance for subscriptions, licenses, or services that has not yet been recognized as revenue. Deferred revenue totaled $489.1 million at the end of 2022 (of which $455.6 million was classified as a current liability with an additional $33.5 million included in other long-term liabilities). We expect to recognize this deferred revenue in future periods as we fulfill our performance obligations under our subscription and service agreements.

The amount of deferred revenue may increase or decrease based on the mix of contracted products and services and the volume of new and renewal subscriptions. The timing of future revenue recognition may change depending on the terms of the applicable agreements and the timing of fulfilling our service obligations. To the extent that there are material differences between our determination of deferred revenue and its expected realization and actual results, our financial condition or results of operations may be affected.

Acquisitions, Goodwill, and Other Intangible Assets

We generally acquire businesses which are accounted for as business combinations. Our financial statements reflect the operations of an acquired business starting from the completion of the transaction. We record the estimated fair value of assets acquired and liabilities assumed as of the date of acquisition.

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To account for each business combination, we utilize the acquisition method of accounting which requires the following steps (1) identifying the acquirer, (2) determining the acquisition date, (3) recognizing and measuring identifiable assets acquired and liabilities assumed, and (4) recognizing and measuring goodwill or a gain from a bargain purchase.

Regardless of whether an acquisition is considered to be a business combination or an asset acquisition, allocating the purchase price to the acquired assets and liabilities involves management judgment. We base the fair value estimates on available historical information and on future expectations and assumptions that we believe are reasonable, but these estimates are inherently uncertain.

Determining the fair value of intangible assets requires significant management judgment in the following areas:

•Identify the acquired intangible assets: For each acquisition, we identify the intangible assets acquired. These intangible assets generally consist of customer relationships, trademarks and trade names, technology-related intangibles (including internally developed software and databases), and in certain acquisitions, noncompete agreements.

•Estimate the fair value of these intangible assets: We may consider various approaches to value the intangible assets. These include the cost approach, which measures the value of an asset based on the cost to reproduce it or replace it with another asset of like utility by applying the reproduction cost method or replacement cost method; the market approach, which values the asset through an analysis of sales and offerings of comparable assets which can be adjusted to reflect differences between the investment or asset being valued and the comparable investments or assets, such as historical financial condition and performance, expected economic benefits, time and terms of sale, utility, and physical characteristics, and the income approach, which measures the value of an asset based on the present value of the economic benefits it is expected to produce utilizing inputs such as estimated future cash flows based on forecasted revenue growth rates and margins, estimated attrition rates and discount rate assumptions.

•Estimate the remaining useful life of the assets: For each intangible asset, we use judgment and assumptions to establish the remaining useful life of the asset. For example, for customer relationships, we determine the estimated useful life with reference to observed customer attrition rates. For technology-related assets such as databases, we make judgments about the demand for current data and historical metrics in establishing the remaining useful life. For internally developed software, we estimate an obsolescence factor associated with the software.

We record any excess of the purchase price over the estimated fair values of the net assets acquired as goodwill, which is not amortized.

We recognize the fair value of any contingent payments at the date of acquisition as part of the consideration transferred to acquire a business. Contingent payments are recognized at fair value at the date of acquisition using either a Monte Carlo simulation, which requires the use of management assumptions and inputs, such as projected financial information related to revenue growth and expected margin percentage, among other valuation related items, or calculating the weighted average of the estimated contingent payment scenarios. The liability associated with contingent consideration is remeasured to fair value at each reporting period subsequent to the date of acquisition considering factors that may impact the timing and amount of contingent payments until the term of the agreement has expired or the contingency is resolved. Any changes in the fair value measurement will be recorded in our Consolidated Statements of Income. In evaluating the characterization of contingent and deferred payments, we analyze relevant factors, including the nature of the payment, continuing employment requirements, incremental payments to employees of the acquired business, and timing and rationale underlying the transaction, to determine whether the payments should be accounted for as additional purchase consideration or post-combination related services.

We believe the accounting estimates related to purchase price allocations, subsequent goodwill impairment testing, and contingent payments are critical accounting estimates because changes in these assumptions could materially affect the amounts and classifications of assets and liabilities presented in our Consolidated Balance Sheets, as well as the amount of amortization and depreciation expense, if any, recorded in our Consolidated Statements of Income. The significance of this policy varies form period to period depending upon the volume of applicable acquisition transactions occurring.

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Recently Issued Accounting Pronouncements

Refer to Note 17 of the Notes to our Consolidated Financial Statements for recently adopted accounting pronouncements as of December 31, 2022.

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